I find that many investors are confused by the distinction between cap rate or cash-on/cash return. Let me clarify... they don't have to be the same. The cap rate can match your cash/on-cash return, but that is only if the property is purchased without financing.
It doesn't matter how wealthy you are, the cap rates of properties will stay the same, so it is easy to measure your profit potential. If you're serious in building wealth, then cap rate will be a crucial metric.
The mortgage expense is not included in the cap rate. This is because it doesn't factor in financing terms, interest rates or any other considerations. This is how it concentrates on the property without all the distractions that come with financing.
The question becomes, "How can I tell if my investment is performing?" Although there are many ways to see your overall investment performance, it is important that sophisticated investors automate as much as possible.
One rule of thumb in regards to cap rate: Good neighborhoods tend to have lower cap rates, while poorer areas are more likely to trade at higher caps. It's generally safe to assume that the 15% cap rate property you find is not in a great place.
Other buildings also influence the cap rate. Consider two buildings in the same location. The updated one may have a cap of 5 percent, while the one in desperate need of renovations might have a cap at 7%.
The most important resource we have is our time. To understand how your properties perform, you should bring in automation. Automated income and expense track will, for example help you quickly calculate NOI. It also allows you more accurately to calculate cap rates in the market.
